We met QL recently at  our  Invest Malaysia, Hong Kong  (IMHK)  event in mid-October.  Management  shared  current  updates  on  all  its  business activities and gave  clearer guidance on  its growth plans. We left  feeling more positive and upbeat on its business expansion plans. We upgrade QL to BUY from Neutral, with TP revised up to MYR3.90  from MYR3.60(a 14.7% upside), based on CY15 earnings P/E of 22x (from 21x). 

Marine  products  remain  key  driver.  QL  continues  to  see  strong demand  for  fishmeal  in  Malaysia  and  Indonesia,  while  sales  for  surimi and  surimi-based  products  are  also  improving.  In  view  of  this,  QL  is adding  new  production  capacity  to  its  Surabaya  plant.  To  enhance  its product offering, QL is also constructing a new snack food factory at its Hutan  Melintang  plant,  which  is  targeted  for  commencement  by  early 2015.  Management  also  expects  its  new  venture  of  shrimp  farming  in Kudat,  Sabah  to  start  contributing  in  the  coming  quarters,  with  shrimp prices remaining strong.

Livestock farming as next contributor.  To capitalise on  the increasing egg  consumption  pattern  in  the  region,  QL  is  looking  to  expand  its livestock  farming  operations  in  Indonesia  and  Viet nam.  QL  is  also currently constructing its new feedmill in Indonesia, as this would help to mitigate  further  margin  erosion  that  would  come  from  the  volatile  feed cost.

Potential  flat  contribution  from  palm  oil.  Management  remainscautious  on the outlook for its palm oil activities, as  unfavourable CPO prices  would  affect  its  plantation  results.  In  addition,  increasing competition for FFB supplies will likely also affect its CPO mill margins.However,  improved  tree  maturity  profile  could  potentially  support  the FFB production growth in  FY15, mitigating the adverse impact from  the softening of CPO prices. 

Raised to BUY. We upgrade QL to BUY (vs Neutral) with a higher TP of MYR3.90 (from MYR3.60), pegged to a new target P/E of 22x CY15 EPS (from  21x  previously),  which  is  within  the  range  of  its  5-year  historical trading  band.  We  ascribe  higher  P/E  target  due  to  its  resilient  growth, with  estimated  2-year  earnings  CAGR  of  22.6%.  QL  has  solid fundamentals and a unique defensive business model.

IMHK feedback.  QL participated in our IMHK event in mid-Oct 2014. Meetings were well  attended,  with  about  20  representatives  from  the  local  funds.  Management shared  some  insight  on  its  current  operation  across  all  business  divisions  and  its expansion plans for the next three years. Feedback from the participants were mostly positive.   

Positive  outlook  on  its  marine  product  manufacturing  (MPM)  division.  QL  is looking to expand the  production capacity of  its Indonesian plant in Surabaya,  aimed at replicating its Malaysian MPM division’s success in Indonesia. QL is adding new capacity  of  5,000  tonnes  per annum  for  fishmeal  and  2,500  tonnes  per annum  forsurimi by 3QFY15, which we have now imputed into our FY15 forecast. Management remains  optimistic  on the outlook  of MPM division, supported by strong demand for fishmeal  in  Malaysia  and  Indonesia,  improving  surimi  price s,  and  better  sales  of surimi-based products.

New  business  ventures.  Management  updated  about  the  group’s  new  venture  of shrimp farming in Kudat, Sabah.  This new project was initiated by the Government via  its  Economic  Transformation  Programme  (ETP)’s  Entry  Point  Project  (EPP)  6, which focuses on improving the production of fully-certified export-quality shrimp for premium  markets  by  establishing  an  Integrated  Zone  for  Aquaculture  Models(IZAQs).  QL  as  one  of  the  EPP’s  champions,  started  the  development  of  marine white  prawn  (Vanamae)  aquaculture  farm  in  January  2013,  with  the  first  intake  of post  larvae  prawns  commencing  in  Apr  2014.  QL  is  looking  to  complete  the construction of all 80 culturing ponds (measuring about 60,000 sq ft per pond) by end of  this  year.  When  completed,  the  farm  will  be  a  full  integration  of  hatchery  farm, growing farm and processing plant. It is worth noting that first partial harvest of white prawn  was  done  in  Jun  2014,  and  management  projects  prawn  harvests  of  1,000 tonnes  and  2,000  tonnes  for  FY15  and  FY16  respectively.  We  also  update  ourearnings  forecasts  accordingly  based  on  these  estimates.  We  are  positive  on  the long-term prospects of the project, which will likely become another source of income for the group.

Aside  from  this,  QL  is  also  constructing  a  new  snack  food  factory  at  its  Hutan Melintang  plant  to  enhance  its  product  offerings.  The  plant  is  targeted  for commencement by early 2015. As this is a new business venture, we believ that the contribution from it will be minimal in FY15. Hence, we are  not including  this into our earnings forecast yet.

Expanding integrated livestock farming (ILF) business.  Management guided that QL’s  egg  production  will  rise  to  4.85m  eggs  per  day  in  FY15  before  increasing  to 5.25m eggs in FY16. This expansion in production is partly to cater for  Indonesia’s market, which has seen QL supplying to more modern chain stores and McDonald’s in  Jakarta  and  Bandung.  QL  is  also  currently  constructing  its  new  feedm ill  in Indonesia to replicate its Malaysia’s supply chain, targeting  for it to be completed by 4Q2015.  Management  believes  that  this  feedmill  would  help  to  mitigate  margin erosion resulting  from volatile feed cost, and assist the company to achieve greater economies of scale. We have updated our FY15 and FY16 forecasts to take this egg production capacity expansion into account. 

Potential hit from softening of CPO prices.  Management  has a  cautious outlook on  the  group’s  palm  oil  activities  (POA)  division,  as  lower  CPO  prices  could potentially  affect  the  contribution  from  both  its  Indonesian  and  Malaysian  estates. Meanwhile, margin at its CPO mill could also potentially hit a snag, as competition for FFB  supplies  is  increasing.  However,  moving  forward,  an  increase  in  matured hectares of its palm trees in Eastern Kalimantan would  support its FFB  production growth, and cushion the impact of softening CPO prices.

Status on take-over offer of Lay Hong Bhd  (LHB).  In  our earlier report dated  25Sep  2014,  we  highlighted  that  QL  had  launched  a  general  offer  for  LHB  shares  it does not own at MYR3.50 per share, in order to tighten its grip on LHB following the removal of  Mr Chia Mak Hooi from LHB’s  board. Mr Chia is  QL’s sole representative on  the  board.  At  this  juncture,  QL’s  management  is  unsure  whether  the  offer  will succeed, as the founding Yap family of LHB owns close to 45% direct and indirect shareholdings in LHB.  We believe the recent announcement made on the extensionof the closing date of the take-over offer (from 5 Nov to 26 Nov 2014) also suggests that  both  companies  are  still  negotiating  on  the  terms  of  the  offer.  It  is  also  worth noting  that since the take-over offer was announced, QL  has been actively acquiring LHB shares on the market, effectively increasing its stakes to 37.3%  currently  from 26.8% (when the general offer was made).  

Risks.  Key  risks  include  volatile  commodity  prices  (eg  CPO,  soy,  corn,  etc)  and potential outbreak of diseases that may disrupt both aquaculture farming and poultry business.Increase  earnings  forecasts.  Our  earnings  forecast  for  FY15F  and  FY16F  have been  nudged higher by 0.7% and 3.3% respectively. We have adjusted our earnings forecasts to take into account the earnings contribution from the marine white prawn aquaculture  farm,  capacity  expansion  for  MPM  division,  and  an  increase  in  egg production.  We  estimate  QL’s  earnings  to  grow  by  20%  in  FY15,  underpinned  bysolid  growth  from  its  MPM  division  and  on-going  regional  expansion  of  its  ILF division. We also take the opportunity to introduce our FY17F EPS estimate of 20.8 sen.

Raise to BUY.  We upgrade QL to BUY (from  Neutral) with a higher TP of MYR3.90 (from MYR3.60), pegged to a new target P/E of 22x CY15 EPS (from 21x previously).We are ascribing a higher target P/E of 22x to take into account its resilient earnings growth. We believe this valuation is fair, given that it is well  within its historical 5-year P/E band range of 11-25x. QL has solid fundamentals with estimated 2-year earnings CAGR of 22.6%. We also believe that QL’s earnings  have  little downside risk due to its  defensive  business  model,  as  its  products  are  mostly  staple  food-based.  W e expect  demand  for  its  products  to remain  robust,  with  minimal  impact  from  softer consumer spending in the medium term.

Source: RHB